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The age of the blanket budget model, with low fares as the unique selling point, is over, industry observers said at an international conference on low-cost airlines here last week.

A new breed of budget airline has emerged that's spurning the golden rules of the tried-and-true low-cost formula -- such as having a single type of aircraft and offering point-to-point service only.

The new model introduces paying perks, such as extra inches to stretch the legs, as a way of differentiating from competitors and sweetening the margins.

'No low-cost airline can survive without the business customer in the long term.'
Thomas Winkelmann, Germanwings

"We think the first phase of low-cost is over. ... We believe that the landscape is changing and some of the basic rules of the low-cost model are not being respected anymore," said Germanwings CEO Thomas Winkelmann. Germanwings is the low-cost offshoot of Deutsche Lufthansa (823212), Germany's leading airline.

"The new low-cost carriers are offering amenities to passengers who are willing to pay for the extra comfort. They are also sometimes flying to central, expensive airports," he said.

This is the strategy adopted by Clickair, the budget arm of Spain's legacy airline Iberia (014720003). Launched in 2006 and based in Barcelona, it flies to major airports in Spain, other European countries and Morocco, and focuses on high-demand routes and frequency. See expanded global coverage.

"We believe there are time-sensitive and product-sensitive customers out there," said Chief Executive Alex Cruz. "We know there are people who prefer to drive less to reach the departure airport and to pay a little more," he added.

Clickair's decision to operate from major airports is in sharp contrast with the business model of Ryanair Holdings (RYA)
RYAAY, +0.09%
Europe's best-known and most successful low-cost airline. Ryanair only operates from secondary airports, generally about an hour's drive away from the destination city. Charges at these airports are much lower, allowing Ryanair to offer better prices.

Brett Godfrey, the chief executive of Australia's Virgin Blue, agreed there's a new kind of low-cost airline. Launched in 2000, Virgin Blue is Australia's second-largest carrier and is based in Brisbane. It has 50 aircraft, and has started moving upmarket by offering service such as extra leg room, a frequent flyer program and lounges.

"The definition of what is a low-cost carrier has changed over the past three to four years," Godfrey said, speaking at the conference. "I'm convinced low-cost must be a state of mind, but that cost cannot be the only criteria," he said.

Godfrey has even coined a new designation for carriers that share this philosophy: "the new world airline."

The rising importance of the business customer

While observers don't dispute the upmarket trend sweeping the low-cost airline industry, individual players disagree on the best strategy to attract customers with bigger wallets.

At Germanwings, Winkelmann is convinced success lies in the airline's ability to win over the business customer.

"No low-cost airline can survive without the business customer in the long term," he said.

The key question is what ratio of bargain-hunting to higher-paying passengers an airline needs on a particular route to make a profit, Winkelmann said. "The rock-bottom-price passenger will always be there. How many you need on your aircraft is the question."

So in an effort to cater to the higher fliers, who Winkelmann said are willing to pay more for the right product, Germanwings uses major airports.

It's also adopted a program called Corporate Flex, which allows business travelers to rebook flights for free and cancel on short notice. The frequent flyer program, called Boomerang, allows members to accumulate miles and redeem them against free flights, albeit with a lower level of complexity than those of legacy carriers such as American Airlines
AMR, -21.55%
or British Airways (BAY).

"Low-cost carriers want simpler frequent-flyer programs," said Alexander Meili, planning director of ICLP, a company that designs and manages loyalty programs for legacy and low-cost airlines.

He explained that the programs adopted by the low-cost carriers tend to reward flying activity rather than distance. They also often offer just one category of mile, have fewer partnerships with car rentals or credit card companies and reward passengers more quickly.

Meili estimated that about 20% of low-cost carriers now have loyalty programs including Vueling in Spain, Air Berlin in Germany and Virgin Blue in Australia. While Southwest Airlines
LUV, +0.42%
pioneered the idea in the U.S. 20 years ago, it wasn't until 2006 that a significant number of European and Asian low-cost airlines started following suit.

Meili said budget airlines are increasingly adopting loyalty programs to differentiate from their competitors but also to generate additional revenue and win the loyalty of customers.

The programs also enable the airlines to gather information and insight into the travel habits of higher-paying passengers.

"The low-cost airlines have a very innovative and refreshing way of looking at these programs...and they're lucky to be able to start from scratch and to be able to limit complexity," he said. In an effort to convey that refreshing approach to its passengers, Vueling called its program "Punto" in Spanish, or just "Point."

Line blurring between low-cost and legacy carriers

According to Virgin Blue's Godfrey, the blurring of lines between legacy and low-cost carriers is the main reason several budget players have abandoned the traditional low-cost model and introduced new services.

"Your appeal gets quite limited if you only address the bargain-hunting market," he said.

While this wasn't a problem when low-cost carriers competed only with high-cost legacy airlines, it has become one as the more-established carriers have restructured, slashed costs and started competing aggressively on price on some routes.

British Airways, for instance, last year introduced an advertising campaign based exclusively on prices for one-way trips, something that would have been unthinkable just a few years ago.

Godfrey, whose airline offers services such as paid-access to a lounge, believes that where a cost advantage cannot be obtained, a budget airline's ability to develop a yield premium thanks to a differentiated service could be "the difference between survival and extinction."

And a survey published last year by Amadeus, a provider of technology and services to the travel industry, and research firm Leflein Associates suggested passengers were willing to pay more for better service or more air miles.

The survey indeed found that 52% of customers would be willing to pay more for the ability to use points to upgrade tickets class, 49% would be wiling to pay for the ability to get more frequent flyer miles than the ticket class allows, 40% would be willing to pay more for the use of an airline's exclusive club and 30% would be willing to pay more for more meals and snacks ordered from a menu.

Still, budget airlines said they're wary of adding services that create too much operational complexity, or end up costing them money.

Paolo Sgaramella, commercial director of Italian low-cost carrier Myair, said there are three key elements to consider before adding a service.

Priority must be given to elements of travel that make the journey more comfortable, he said. And the partner offering the service must be technology savvy, so that adding it generates no operational headaches for the airline. Finally, the service has to "create value," in other words, bring in some cash.

So enjoy those leather seats while they last. As for the more complex elements of upscale travel, it may be some time yet before they take off.

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